As I set out to pen this post, I went through the available literature on the microfinance industry; global and Indian. The extent of scholarly articles and expert comments by economists, sociologists, activists and public on microfinance industry is truly amazing and humbling. Central banks of nations, Indian and international banks, rating agencies and the World Bank have been active participants and facilitators of the microfinance industry. India, especially the State of Andhra Pradesh, has been a silent leader in generation and distribution of microfinance. It is, therefore, sad that the Indian microfinance industry should have caused, either by inadvertent design or involuntary default, waves of suicides of indigent borrowers and thus is now itself suffering from the terrible backlash of such suicides.
Experts agree that microfinance has performed and would continue to perform a very useful purpose of reaching credit to the highly indigent and impoverished rural population. In India microfinance registered a meteoric increase from USD 250 milion in 2005 to USD 4 billion in 2010, serving millions of indigent households. Indian banks and financial institutions including subsidiaries of foreign banks have lent USD 3.3 billion to microfinance sector. Seeing the potential multiple other direct and mezzanine funding options became available to the Indian microfinance industry. Securitization of microfinance disbursements became another funding tool. Low delinquency of loans, managed by aggressive recovery methods, ensuring continued fund flow.
Clearly, the rapid and unregulated evolution of the industry led to multiple borrowings, usurious lending rates, and high-handed collection mechanisms to state a few. What ought to be a bank-aided socially purposive activity became a private equity driven business with profits and valuations as the goal. The Government of Andhra Pradesh promulgated an ordinance in October 2010 to regulate the industry while the Reserve Bank of India has constituted an expert committee to examine the industry in its entirety. International reviewers such as Financial Times, Forbes and Wall Street Journal while recognizing and condemning the follies and inadequacies of the microfinance sector have cautioned against mistaking the procedural weakness of the current microfinance industry as proof of the irrelevance of the industry.
Surely, the various efforts would lead to a more regulated microfinance industry that would stop the profitable piggybacking of the microfinance firms on not-for-profit Self Help Groups. The new policy would also hopefully establish a reasonable proportionality between the low-cost priority sector credit from scheduled banks that the microfinance industry is entitled to, and the interest rate that the industry would charge to its indigent and impoverished clientele. Probably, these measures will take some profit and valuation sheen off the microfinance industry but will be welcome for their positive impact of preventing a social disaster - of a new breed of urban bankers profiteering at the expense of the bottom of the rural pyramid.
Microfinance : a workaround road or a new credit highway?
The banks in India have an obligation to direct 40 percent of their credit to priority sector, which includes the indigent customers who constitute the customer base of the microfinance industry. Despite their efforts and establishment of several collateral institutions like cooperative banks, regional rural banks and specialist institutions such as NABARD by the central and state governments, the organized banking sector has trditionally failed to ensure a performing priority sector portfolio. The emergence of microfinance firms has enabled the banking system find an effective intermediary that fulfilled its purpose. The microfinance industry brought a rare on-ground control over micro-credit deployment and collection, and emerged as a preferred alternative to the ruthless moneylenders that held the impoverished people to ransom. Empowerment of women was a key plank of the microfinance movement bringing a higher level of acceptability to the sector.
Probably, the very availability of organized low-cost funds for the microfinance industry and the low bar of performance arising from a benchmark of traditional money lender system have led to the imperfections of the microfinance industry. Some economists characterize the microfinance system as an unfortunate work-around methodology for the failure of the mainstream financial institutions to reach credit to the poor while others predict a schumpeterian dead end for the microfinance industry. An eminent former governor of the Reserve Bank of India who is credited with saving the Indian financial system from the global liquidity meltdown felt that microfinance is a kind of sub-prime lending which is not sustainable in the long run. Others believe that despite the noble objectives, the microfinance industry performs no more than a sustenance role that is far from the transformational aspiration that the industry is charged with. The supporters of the microfinance industry, on the other hand, argue that the low cost structure of microfinance firms provides the much needed competitive advantage vis-à-vis the mainstream firms and the microfinance firms would eventually grow into financial behemoths in future.
Regardless of the arguments, it appears that the microfinance industry is in need of a significant paradigm shift in terms of three key fundamental approaches: (i) from lending to investment, (ii) from consumption to employment, and (iii) from competitive growth to collaborative development, if micro-financing has to be transformational. The industry needs to evaluate whether it is truly equipped to make micro entrepreneurs out of the millions of the poor, less literate people it serves or it would be better of generating more sustainable employment development by focusing on thousands of capable rural entrepreneurs. The governments have to also evaluate if the microfinance industry would serve its social purposes better by getting funded more by public equity funding than by private equity funding. In sum, there are more fundamental issues involved in the reincarnation and rejuvenation of the scalded microfinance industry than procedural regulations, essential though they are.
From lending to investment
The biggest point against the current microfinance model is that it is addressed at survival and consumption needs of the rural customers. Most microfinance customers are indigent individuals who lack ownership of any assets and are therefore incapable of generating additional income streams out of the loans taken. While the end-use details of loan amounts are presumably sought as per the loan clearance processes, clearly the processes are deficient as demonstrated by the multiple loans taken from multiple institutions by the individuals. It is important, therefore, to have a transformational view of the lending process by the microfinance institutions and the individual beneficiaries. The lending process needs to be viewed as an investment process aimed at asset ownership and supplementing asset management for, and by, individuals.
The next important point is whether microfinance institutions can see themselves as micro investors and not as micro lenders. As opposed to lending, the institutions should see themselves as investors in the notional equity of the individuals they lend to. This approach requires a shift from a quantitative view to a qualitative view of lending by the institutions. It also requires the microfinance institutions to view themselves as development institutions rather than lending institutions. If the institutions are benefitted by private or public equity it is incumbent, given the social objectives the sector has, to invest part of the proceeds as risk-bearing investment capital. This, ipso facto, would compel the institutions to be more alert and helpful towards the borrowers from a sustainability point of view.
A sore point against the current microfinance model is the rather uncapped and usurious rates of interest. The institutions need to compete with low cost bank finance providers rather than the high cost traditional moneylenders. In a regime where even high cost credit cards charge monthly flat interest rates of 2.5 to 3 percent it is inappropriate to have uncapped interest rates going up to as high as 5 percent flat, as allegedly charged by certain microfinance companies. Regular auditing of the books would help keep a semblance of control to this essential requirement. More fundamentally, however, the founders of microfinance institutions should stop viewing their operations from a traditional profit-oriented business angle and aggressive revenue/profit optics, and instead see themselves as instruments of social transformation.
From consumption to employment
Closely allied with the investment approach outlined above is the employment approach. The principal macroeconomic objective of microfinance must be to generate sustainable employment. This objective can be fulfilled by focusing on employment generation capability of the village as a whole rather than individuals per se. This requires a study of what the village economy currently has, what it is capable of generating and what it is capable of marketing. The study also requires an evaluation of the training and development needs of the individuals. In other words, there needs to be a strategic employment plan developed by the institution with respect to each village it desires to focus on.
Employment generation is dependent on the ability of people to be self-reliant eventually. Possibly, not all indigent individuals would be capable of being self-employed. It makes sense to create employability in a village as a whole rather than just provide loans to all individuals to be self-reliant. Microfinance would be more than fulfilling its promise if identifies entrepreneurially talented individuals in the village system to set up small and medium businesses that can provide larger scale employment. The focus of microfinance institutions in this approach would be more effective if it provides a learning and development school or enrollment in a vocational school as a means to improve the employability of individuals.
Fundamentally, micro-financing in a rural, or for that matter even in an urban, setting cannot be independent of the sociological trends in a village. Many village social and economic structures and systems are overwhelmed by decades and century old practices. It is important for the microfinance firms to understand the sociological setting of each village it focuses on so that plans of employment generation or produce marketing do not flounder on social barriers. Future organizational and talent structures of microfinance firms must encompass sociologist positions as important components, virtually on par with credit agents and collection agents.
From competitive growth to collaborative development
Microfinance, with all the socio-economic ramifications, is not the appropriate sector for competitive growth of firms. Yet, it seems to be the malady afflicting the industry with examples set by phenomenal profitability and profitability of certain firms. As the industry comes into public scrutiny it would be impossible, besides being inappropriate, to continue the model of competitive growth. In particular, microfinance firms must be open to the criticism that they have unduly benefitted from the prior work done by Self Help Groups (SHGs). One expert commentator has gone to the extent of stating that while the SHGs prepared the meals with great dedication and effort the microfinance firms simply came on to the scene, and enjoyed the meals. The fundamental requirement, going forward, for microfinance firms must be collaborate with not-for-profit and other SHGs.
Secondly, microfinance cannot be independent of socio-political implications. The backlash in Andhra Pradesh is clearly indicative of this. Microfinance firms must deal with this requirement in an open manner rather than through behind the scene arrangements. A model of inclusive development by co-opting political representatives on strategic boards for villages or constituencies could be one solution. Equally, it would be important to integrate the government machinery dedicated to rural development in their extended organizational structures. These requirements, in turn, call for broad-basing their organizational structures and boards by including ex-bureaucrats and social activists in them.
Thirdly, microfinance firms need to collaborate with other firms in their corporate social responsibility activities. In fact, microfinance firms could be the major instruments for carrying out or supplementing corporate social responsibility activities. The collaborative links would be financial, and beyond. For example, collaboration with ITC which has done significant rural development through its path-breaking e-choupal initiative could bring in significant synergies. Such collaborations would help bring technology to the door step of borrowers and make them better equipped to handle the technological requirements of employability. Collaborations with consumer firms which are dedicated to develop low cost products and services for the rural population would also be in order.
Fourthly, education should be the sheet anchor of microfinance movement. Considering that the industry is neither organized nor equipped to handle education as its offering or a core purpose, collaboration with corporate firms engaged in educational initiatives would be in order. Virtually every firm today is committed to supporting education. While some companies have established foundations for the purpose some companies have taken up “Teach India” initiatives involving voluntary participation by socially responsive professionals. As clientele of microfinance institutions become more educated it would trigger a virtuous cycle of microfinance with the ability to cover an ever enlarging canvas of the indigent society.
A positive future beckons
As this blog post demonstrates, notwithstanding the setbacks and controversies, microfinance has an important role in ushering a more inclusive growth of the Indian society with a focus on the bottom of the pyramid. Microfinance in India has a socio-economic role that other sectors of the economy would find difficult to match. This would require the microfinance industry as a whole to be more regulated and structured while redefining itself on the dimensions of investment, employment and collaboration outlined herein. It is incumbent upon the government agencies, political institutions, banks and financial institutions and corporate firms to understand the importance of microfinance and back the sector with appropriate and apolitical policy support. Organizationally, microfinance firms would need to bring on board economists, sociologists and public servants to provide the required socio-economic thrust to this important economic sector.
Posted by Dr CB Rao on December 26, 2010